Randomly Noted

Here’s a great quote from the Financial Crisis Inquiry Commission report that  was released earlier today:

“It didn’t take Sherlock Holmes to figure out this was bogus.” That’s from Prentiss Cox, then an assistant attorney general with the state of Minnesota. He was talking about loan applications he reviewed from a mortgage lender who later went bust,

Cox received 10 boxes of applications from the mortgage lender and began to pull out random files. Here a pretty healthy mortgage was given to a disabled borrower in his 80s who used a walker and was described in the loan application as being employed in light construction.

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They all wanted to be like Mike (remember the Michael Jordan commercials from yesteryear?)

In this case, they were every Wall Street firm. And Mike was Goldman Sachs. There was this envy of by every Wall Street firm to be as successful as the secretive Goldman Sachs.  It was strong in equities, bonds, investment banking. And so, when Stan O’Neal took control of Merrill Lynch, the idea was that he wanted to compete with the likes of Goldman. More risk was taken on, a big cultural shift was underway. In one year, Merrill went from a firm with 45 billion to $6 billion exposure in subprime mortgages to one with $55 billion. It went overboard with collateralized debt obligations.

It’s hard to imagine how the European credit crisis that hit hard many of the banks there could have an effect on bondholders of a housing agency in the U.S. whose reason for being is to provide affordable loans for first time home buyers. But that’s what could play out for investors – likely Mom and Pop types – who hold some $3 billion of mortgage revenue bonds issued by the Ohio Housing Finance Agency.

The housing agency, and apparently many other municipalities, have invested some of their funds in guaranteed investment contracts issued by a company called Pallas Capital Corp. The Ohio agency has some $106 million tied up with the Pallas GICs.  Some investors look to GICs as a means to extract a little extra yield. It’s not known what these particular securities were yielding.

Pallas sold GICs and then invested those proceeds in reverser repurchase agreements that were collateralized by a pool of structured finance and corporate assets, according to Moody’s Investors Service Inc. Moody’s recently downgraded the Pallas GICs because “the GICs are a direct pass-through rating of the reverser repo counterparty, DEPFA Bank. You know what’s coming next – DEPFA was recently downgraded on its ability to pay back short term loans.

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The Bank for International Settlements released its triennial survey on the foreign exchange markets last night  and among the mounds of all of the interesting numbers (interesting to those of us who care about forex) were some trends worth noting. For starters, spot trading was up nearly 50% – and that was driven by the traditional trading between banks but even more so by trading by hedge funds, pension funds and mutual funds, among those characterized as “other financial institutions.”

So, proprietary trading was in full force at the banks – which we know has been a profit center in recent quarters for some firms. And we continue to see the larger role played by institutions like hedge funds.

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Three major financial institutions reported earnings today (GE Capital, the finance unit of GE, along with Citigroup and Bank of America) and while all were profitable, one sore spot stuck out when you dug through the mounds of data each company reported: Commercial real estate remains a big drag.

GE Capital had net income of $830 million – and that was after it lost $524 million in its real estate portfolio. The unit said it wrote off $186 million of bad commercial real estate debt and had $1.6 billion of non-performing assets. It placed at $6.3 billion its unrealized real estate loss.

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Like settlements should, the one just announced between the Securities and Exchange Commission and Goldman Sachs & Co. seems to have significant ‘wins’ for both sides.

For Goldman, it puts an open investigation, that featured a high-profile Congressional hearing, behind it. That’s at least for the civil charge brought by the SEC. It was a lingering public relations headache that was part of a larger negative image as the big bad investment bank that Goldman’s been fighting in the aftermath of the credit crisis.

For the watchdog SEC, there’s the acknowledgment by Goldman of incomplete marketing materials (the firm neither admitted nor denied the allegations), along with a payment of $550 million, some of which will go to the investors who lost on teh deal.

The SEC’s director of enforcement, Robert Khuzami, called it the “largest penalty ever assessed against a financial services firm in the history of the SEC.”

Here’s a simplistic description of the circumstances. Goldman created a synthetic mortgage security. The mortgages that went into the security, thus helping determine its creditworthiness, were selected in some part by a hedge fund that intended to go short the security, benefiting if it went bad.

Goldman didn’t tell the buyers.

On one level it seems simple. If you are a buyer you want to know. But the legalisms are different. And Goldman vehemently denied wrongdoing, citing the sophistication of the buyers and its role as market maker.

Curious that while settling with Goldman, the SEC said its litigation continues against Fabrice Tourre, the vice president of Goldman at the center of the controversy. It shows that in many cases of official investigations, at some point the interests of the corporation and the individual diverge.

Both sides probably made the best deal they could, given the political and legal context.

The bailout package for Greece has not stemmed the bleeding in global markets, but for Asia the declines in currencies and stocks may soon lure investors back in.

What we are seeing is Asia and the U.S. catching a cold from Europe, as violence grows in Greece over the planned austerity measures and as ratings agencies sound warnings on the fiscal health of others in the region, including Spain and Portugal.

Just as an example, Hong Kong’s share market has fallen three days in a row, losing 3.7% over that period, while the Taiwan dollar Wednesday fell to its lowest level against the greenback since April 9. Thursday, the Nikkei is down more than 3.0% and South Korea’s Kospi has shed 2.3%, with the Korean won around six-week lows against the U.S. dollar.

The declines in Asia, which have included a widening in credit default swaps in an otherwise encouraging environment for the region’s companies and debt, come as investors react to the latest woes in the euro-zone.

The contagion though for now is peripheral; it’s just the end result of a fading global mood for risk. Strip that away, and what do you find?

Asian banks have minimal exposure to European debt–certainly that from Greece, Spain and Portugal. It seems prudence continues to win the day. Asian banks and their economies came through the recent U.S.-induced financial crisis in relatively good shape precisely because they had steered clear of subordinated debt products and repackaged debt generally.

Asian governments have also–some more so than others–worked to overcome the frailties in their banking and financial systems that were exposed so violently when the Asian financial crisis hit more than a decade ago. That’s left systems in much stronger shape, and central banks much better armed with foreign exchange reserves.

The region’s economies have also been faster and more convincing in their recovery over the past six to 12 months. Many challenges remain, none the least from how and when to exit the large spending measures put in place during the crisis, and how and when to tighten monetary policy (as inflation starts to rise), but if there’s one place that offers any sort of sanctuary right now, it would be Asia.

The region needs Europe and the U.S. to keep buying its products, but intra-regional trade has taken up some of the slack, particularly from China.

Sounder economic fundamentals and a stronger banking system mean Asian markets may soon appear more attractive to investors in currencies and stocks (and also the better Asian credits), even if the Greek wobbles continue. It would take a lot more than what we’re currently seeing to suggest we’re heading anew for some sort of global banking or debt crisis.
That may mean the declines start to slow over the coming week as value appears.

A record 40,000 people are expected to show up at Berkshire Hathaway Inc.’s annual “Woodstock for capitalists,” otherwise known as the Berkshire annual meeting.

The unique Omaha event finds Berkshire at a bit of an odd crossroads. It had a strong 2009, a year in which the firm made a big bet on railroads.

But as successful as Warren Buffett and his partner, Charlie Munger, have been as investors for so many years, they also have been about more than just strong returns. They have occupied a moral high ground in an investment world where sticking strictly to the legal minimums is more the norm.

That Berkshire is somehow expected to behave differently than other large investors is probably a bit unfair to Berkshire. Still, there likely were some disappointed fans when it was reported that Berkshire did some lobbying to try to protect its own interests in the financial regulation bill now the center of Senate attention.

To add to this, the lobbying was about derivatives and collateral that needs to be held against derivatives positions.

The fact that Buffett and Berkshire have derivatives positions at all likely surprised some, given Buffett’s vocal condemnation of them.

But clearly Buffett and group saw a trading advantage in derivatives and acted. Lobbying was done to try to prevent the passage of legislation that would put Berkshire at a disadvantage.

So Buffett and Berkshire seem a bit more like everyone else in the investment community, just more successful than most. Nothing wrong with that. That pedestal just gets in the way, anyhow.

When the major credit ratings agencies found themselves on the hot seat some years ago after the accounting scandals at Enron and Worldcom, their defenses were reasonable.

If those fraud-ridden companies were essentially handing out inaccurate financials, it meant the ratings agencies were being duped like everyone else. After all, you couldn’t expect Standard & Poor’s and Moody’s Corp. to act as auditors. So, their ratings of the companies were too high when the companies’ real and troubling situations tumbled into public view.

Around the same time, the business models of the major ratings agencies were called into question – they are paid by the issuers whose securities they rate. The ratings agencies said they knew how to handle the apparent conflicts and because they were employed by so many issuers, the potential conflict was diminished as no one company represented a large percentage of the raters’ revenues.

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Click on above image for WSJ editorial on Goldman Sachs

This blogger is sure that in the coming days and week, we’ll learn more about what Goldman Sachs did or didn’t do in relation to creating an exotic security that blew up on two sophisticated investors, resulting in Goldman being charged with fraud by the Securities and Exchange Commission last week.

But one thing is for certain – Goldman Sachs didn’t force ACA Financial, or IKB Industriebank, a German bank, to buy the securities. Presumably, they did some of their own research into the quality of the underlying securities that their collateralized debt security was tied to.

Or maybe not.

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